1. A speculator is considering the purchase of two three-month British pound call options with a striking price of $1.56 per £. The premium is $0.03 per pound. The standard size of each option contract is 10,000 pounds.
(a) Determine the future spot price at which the speculator will only break even.
(b) What would be the speculator’s profit if the pound depreciates to $1.54 per £?
(Please include currency symbols $, £ in your answer)
2. Microsoft would like to borrow pounds, and Boots wants to borrow dollars. Because Microsoft is better known in the United States, it can borrow on dollars at 5.5% and pounds at 7%, whereas Boots can on its own borrow dollars at 6% and pounds at 6.5%. Suppose Microsoft wants to borrow £1 million for two years, Boots wants to borrow $1.6 million for two years, and the current ($/£) exchange rate is $1.60/£. What swap transaction would accomplish this objective? Assume the counterparties would exchange principal and interest payments with no rate adjustments.
(Please include currency symbols $, £ in your answer)